“It is especially important to recognize that the (predictable) impact of fiscal austerity has been to reduce output in the periphery countries, not raise it, and thereby to raise debt/GDP ratios, not lower them,” Frankel writes. “The leaders have finally taken some steps in the right direction over the last year: movement toward a banking union; more adjustment time for Greece, Portugal and Spain; and ECB bond purchases. But for the countries that are to remain in the euro, much adjustment still lies ahead.”

Frankel identifies three distinct sets of “difficulties” which, he contends, were “built into the monetary union from the beginning” – the competitiveness problem; the fiscal problem; and the banking problem – all of which, he claims, will require “wrenching changes” in the years ahead.

The changes, Frankel writes, include more debt reduction, considered very painful for the northern states, and more internal devaluation, considered painful for those countries in the south.

Frankel says long term salvation could also take the form of a “red bonds/blue bonds” regime, through which countries would be strongly incentivized to reduce debt levels below 60 percent of GDP.

“Under this plan, only debt issued by national authorities below the 60% criteria would receive eurozone backing and effectively become Eurobonds. These are the “blue bonds” that would be viewed as safe by investors. When a country issued debt above the 60% threshold, the resulting “red bonds” would lose eurozone backing. The individual member state would be liable for them,” Frankel says. “Of course the euro countries cannot jump to a blue bond regime without first solving the debt overhang problem that is front and center.”

Jeffrey A. Frankel is James W. Harpel Professor of Capital Formation and Growth. He directs the Program in International Finance and Macroeconomics at the National Bureau of Economic Research, and served at the White House Council of Economic Advisers in 1983-84 and 1996-99. His research interests include international finance, commodities, currencies, crises, monetary policy, fiscal policy, regional blocs, and international environmental issues.

Frankel identifies three distinct sets of “difficulties” which, he contends, were “built into the monetary union from the beginning” – the competitiveness problem; the fiscal problem; and the banking problem – all of which, he claims, will require “wrenching changes” in the years ahead.